Get ready for IFRS 9
The impairment requirements
IFRS 9 (2014) ‘Financial Instruments’ fundamentally rewrites
the accounting rules for financial instruments. It introduces
a new approach for financial asset classification; a more
forward-looking expected loss model; and major new
requirements on hedge accounting.
While IFRS 9’s mandatory effective date of 1 January 2018
may seem a long way off, companies really need to start
evaluating the impact of the new Standard now. As well as
compiling the information necessary to implement the
Standard, companies will need to review loan covenants and
other agreements that could be affected by the impact on
reported results.
This is the second in a series of publications designed to
get you ready for IFRS 9. In this issue, we bring you up to
speed with the Standard’s new impairment requirements.
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Issue 2 March 2016
Get ready for IFRS 9
Contents
1Introduction
1
2
Scope of the new impairment requirements
3
3
The general (or three-stage) impairment approach
6
3.1
Overview7
3.2
Impact of a significant increase in credit risk
3.2.1
Identifying a significant increase in credit risk
11
3.2.1.1
Definition of default
11
3.2.1.2
Interaction with the level of credit risk on initial recognition
13
3.2.1.3
Interaction with the length to maturity of an instrument
14
3.2.1.4
Reasonable and supportable information
14
3.2.1.5
Rebuttable presumption for payments more than 30 days past due
14
3.2.1.6
Multi-factor analysis
15
3.2.1.7
Individual or collective assessment
15
3.3
Measuring expected credit losses
17
3.3.1
General principles
17
3.3.2
Probability-weighted amount
18
3.3.3
Time value of money
18
3.3.4
Reasonable and supportable information
19
3.3.5
Measurement of expected credit losses for different types of asset/exposure
20
3.4
Application issues
20
3.4.1
Period to consider when measuring expected credit losses
20
9
3.4.2Collateral
21
3.5
Practical expedients
21
3.5.1
‘Low credit risk’ exception
21
3.5.2
Other practical expedients
22
4
Simplified model for trade receivables, contract assets and lease receivables
23
4.1
Overview24
4.2
Applying the simplified model
25
5
Purchased or originated credit-impaired financial assets
28
6
Presenting credit losses
31
6.1
Financial assets measured at amortised cost
32
6.2
Financial assets measured at fair value through other comprehensive income
32
7Disclosures
34
8
36
Practical insight – next steps
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1. Introduction
Under IFRS 9, recognition of impairment no longer depends on a reporting entity first
identifying a credit loss event. This is a major change from the previous Standard, IAS 39.
IFRS 9 instead uses more forward-looking information to recognise expected credit losses
for all debt-type financial assets that are not measured at fair value through profit or loss.
This section gives a high level overview of the changes and explains why they were
necessary.
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Get ready for IFRS 9
In July 2014, the IASB issued IFRS 9’s impairment requirements. These fundamentally
rewrite the accounting rules for impairment of financial assets.
The IASB’s aim is to rectify a major perceived weakness in
accounting that became evident during the financial crisis of
2007/8, namely that IAS 39 ‘Financial Instruments: Recognition
and Measurement’ resulted in ‘too little, too late’ – too few
credit losses being recognised at too late a stage. IAS 39’s
‘incurred loss’ model delayed the recognition of impairment
until objective evidence of a credit loss event had been
identified. In addition, IAS 39 was criticised for requiring
different measures of impairment for similar assets depending
on their classification.
IFRS 9’s impairment requirements use more forward-looking
information to recognise expected credit losses for all debt-type
financial assets that are not measured at fair value through
profit or loss (and for some other credit exposures – see
‘practical insight’ box on loan commitments and financial
guarantees in section 2). One consequence is that a credit loss
arises as soon as a company buys or originates a loan or
receivable – a so-called ‘day one loss’. Unlike IAS 39, the
amount of the recognised loss is the same irrespective of
whether the asset is measured at amortised cost or at fair
value through other comprehensive income.
Recognition of impairment therefore no longer depends on the
company first identifying a credit loss event. Instead an entity
always estimates an ‘expected loss’ considering a broader
range of information, including:
•past events, such as experience of historical losses for
similar financial instruments
•current conditions
•reasonable and supportable forecasts that affect the
expected collectability of the future cash flows of the
financial instrument.
In the following sections we help you evaluate the Standard’s
requirements, and the challenges that it will bring.
Recognition of impairment no longer depends on first
identifying a credit loss event. Instead all entities will
recognise expected credit losses.
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2. Scope of the new
impairment requirements
IFRS 9’s impairment requirements apply to all debt-type assets that are not measured at
fair value through profit or loss.
Certain other credit exposures that were outside the scope of IAS 39 are also within the
scope of the Standard.
Investments in equity instruments are outside the scope of the impairment requirements as
they are measured at fair value.
This section explains the scope of the impairment requirements in more detail and
comments on some of the practical implications.
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Get ready for IFRS 9
IFRS 9 (2014) requires an entity to recognise a loss allowance for expected credit
losses on:
•debt instruments measured at
amortised cost
•debt instruments measured at
fair value through other
comprehensive income
•lease receivables
•contract assets (as defined in IFRS 15
‘Revenue from Contracts with
Customers’)
•loan commitments that are not
measured at fair value through
profit or loss
•financial guarantee contracts
(except those accounted for as
insurance contracts).
IFRS 9 requires an expected loss
allowance to be estimated for each of
these types of asset or exposure.
However, the Standard specifies three
different approaches depending on the
type of asset or exposure:
Three approaches
Type of asset/exposure Applicable model
Described in
Trade receivables and
contract assets without
a significant financing
component*
Simplified (lifetime
expected loss) approach
Section 4
Assets that are
credit-impaired at
purchase or origination
Change of lifetime
expected loss approach
Section 5
Other assets/exposures
General (or
three-stage) approach
Section 3
* optional application to trade receivables and contract assets with a significant financing
component, and to lease receivables
The Standard specifies three different approaches
depending on the type of asset or exposure.
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The impairment requirements
Practical insight – loan commitments and financial
guarantees
Loan commitments
Similar to IAS 39, IFRS 9 requires some loan
commitments to be measured at fair value through profit
or loss (those that can be net cash-settled or which oblige
the issuer to lend at a below-market rate). Unlike, IAS 39,
however, other loan commitments are subject to IFRS 9’s
impairment model. This is an important change compared
to IAS 39.
Practical insight – equity instruments
Under IFRS 9, investments in equity instruments are
measured either at fair value through profit or loss
or at fair value through other comprehensive income.
Impairment of such assets is unnecessary as they are
measured at fair value, and they are therefore outside the
scope of IFRS 9’s impairment requirements.
Unlike IAS 39, it is not possible under IFRS 9 to
measure investments in equity instruments at cost where
they do not have a quoted market price and their fair
value cannot be reliably measured.
Financial guarantees
Financial guarantee contracts are also within the scope of
IFRS 9’s expected loss requirements for the issuer, unless
they have previously been accounted for as insurance
contracts under IFRS 4 ‘Insurance Contracts’ and the
entity elects to continue to account for them as such.
This election is irrevocable and cannot be applied to an
embedded derivative where the derivative is not itself a
contract within the scope of IFRS 4.
Implications
For financial institutions that manage off-balance sheet
loan commitments and financial guarantee contracts
using the same credit risk management approach and
information systems as loans and other on-balance sheet
items, this might prove to be a simplification. For other
institutions that issue these types of instruments, the new
requirements could be a significant change, necessitating
adjustments to systems and monitoring processes for
financial reporting purposes.
Investments in equity instruments are measured either
at fair value through profit or loss or at fair value through
other comprehensive income. Impairment of such assets
is therefore unnecessary.
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3. The general (or threestage) impairment approach
IFRS 9’s general approach to recognising impairment is based on a three-stage process
which is intended to reflect the deterioration in credit quality of a financial instrument.
•Stage 1 covers instruments that have not deteriorated significantly in credit quality
since initial recognition or (where the optional low credit risk simplification is applied)
that have low credit risk
•Stage 2 covers financial instruments that have deteriorated significantly in credit
quality since initial recognition (unless the low credit risk simplification has been applied
and is relevant) but that do not have objective evidence of a credit loss event
•Stage 3 covers financial assets that have objective evidence of impairment at the
reporting date.
12-month expected credit losses are recognised in stage 1, while lifetime expected credit
losses are recognised in stages 2 and 3.
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The impairment requirements
This section starts with an overview of the general (or three-stage) model discussed
on the previous page before looking in detail at how to identify a significant increase
in credit risk; the measurement of expected credit losses; application issues that are
likely to be encountered; and practical expedients that are available.
3.1 Overview of the general
approach
IFRS 9 draws a distinction between
financial instruments that have not
deteriorated significantly in credit quality
since initial recognition and those
that have.
‘12-month expected credit losses’ are
recognised for the first of these two
categories. ‘Lifetime expected credit
losses’ are recognised for the second
category. Measurement of the expected
credit losses is determined by a
probability-weighted estimate of credit
losses over the expected life of the
financial instrument.
An asset moves from 12-month
expected credit losses to lifetime
expected credit losses when there has
been a significant deterioration in credit
quality since initial recognition. Hence the
‘boundary’ between 12-month and lifetime
losses is based on the change in credit
risk not the absolute level of risk at the
reporting date.
There is also an important operational
simplification (one of several in the new
Standard) that permits companies to stay
in ‘12-month expected credit losses’ if
the absolute level of credit risk is ‘low’.
This applies even if the level of credit
risk has increased significantly. See
Section 3.5.1.
What are ‘credit losses’?
Credit losses are defined as the difference between all the contractual cash
flows that are due to an entity and the cash flows that it actually expects to
receive (‘cash shortfalls’). This difference is discounted at the original effective
interest rate (or credit-adjusted effective interest rate for purchased or
originated credit-impaired financial assets).
What are ‘12-month expected credit losses’?
•12-month expected credit losses are a portion of the lifetime expected
credit losses
•they are calculated by multiplying the probability of a default occurring on
the instrument in the next 12 months by the total (lifetime) expected credit
losses that would result from that default
•they are not the expected cash shortfalls over the next 12 months.
They are also not the credit losses on financial instruments that are forecast to
actually default in the next 12 months.
What are ‘lifetime expected credit losses’?
Lifetime expected credit losses are the expected shortfalls in contractual cash
flows, taking into account the potential for default at any point during the life of
the financial instrument.
An asset moves from 12-month expected credit losses
to lifetime expected credit losses when there has been
a significant deterioration in credit quality since initial
recognition.
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There is also a third stage. This applies
to assets for which there is objective
evidence of impairment (essentially the
same as objective evidence of an
incurred loss in IAS 39). In Stage 3 the
credit loss allowance is still based on
lifetime expected losses but the
calculation of interest income is different.
In the periods subsequent to initial
recognition, interest is calculated based
on the amortised cost net of the loss
provision, whereas the calculation is
based on the gross carrying value in
Stages 1 and 2.
Finally, it is possible for an instrument
for which lifetime expected credit losses
have been recognised to revert to
12-month expected credit losses should
the credit risk of the instrument
subsequently improve so that the
requirement for recognising lifetime
expected credit losses is no longer met.
We refer to the model described above
as the ‘general approach’. As noted in the
diagramme in section 2, there are two
exceptions to this general approach:
•a simplified approach for trade
receivables, contract assets and
lease receivables – see Section 4
•an approach for purchased or
originated credit-impaired financial
assets – see Section 5.
The three-stage process under the ‘general approach’
Stage 1 (performing)
Stage 2 (under-performing)
Financial instruments that have not
deteriorated significantly in credit
quality since initial recognition or
(where the optional simplification
is applied) that have low credit risk
at the reporting date
Financial instruments that have
deteriorated significantly in credit
quality since initial recognition
(unless the optional simplification
is applied and they have low credit
risk at the reporting date) but that
do not have objective evidence of
a credit loss event
Financial assets that have
objective evidence of impairment
at the reporting date
12-month expected credit losses
are recognised
Lifetime expected credit losses
are recognised
Lifetime expected credit losses
are recognised
Interest revenue is calculated
on the gross carrying amount of
the asset
Interest revenue is still calculated
on the asset’s gross carrying
amount
Interest revenue is calculated on the
net carrying amount (ie reduced for
expected credit losses)
Practical
expedient
Recognition
of interest
Recognition of
expected credit
losses
Credit quality
Deterioration in credit quality
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Low credit risk
Stage 3 (non-performing)
Credit risk > low
The impairment requirements
3.2 Impact of a significant increase
in credit risk
Under IFRS 9’s general impairment
model, the way in which the allowance for
expected credit losses is calculated
changes as the credit risk of a financial
instrument deteriorates significantly.
As noted above, the loss allowance is
generally measured at 12-month
expected credit losses if, at the reporting
date, its credit risk has not increased
significantly since initial recognition. This
also applies if credit risk has increased
significantly but:
•the company has chosen to apply the
‘low credit risk’ operational
simplification (see section 3.5.1); and
•the absolute level of credit risk is low.
Impact of a significant increase in credit risk
Has there been a significant increase in the instrument’s credit risk?
No
Yes
Has the entity chosen to apply
the ‘low credit risk’ operational
simplification?
No
Yes
Is the credit risk of the instrument
low?
No
Yes
Recognise lifetime expected credit
losses
Recognise 12-month expected
credit losses
Otherwise, if credit risk has increased
significantly since initial recognition, the
credit loss allowance is measured at
lifetime expected credit losses.
It is possible for an instrument for which lifetime expected
credit losses have been recognised to revert to 12-month
expected credit losses should the credit risk of the
instrument subsequently improve.
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Example – 12 month versus lifetime expected credit losses
Entity B has a reporting date of 31 December. On 1 July 20X1 Entity B advanced a 3-year
interest-bearing loan of CU2,000,000 to Entity A. Management estimates the following risks
of defaults and losses that would result from default at 1 July 20X1 and at 31 December
20X1 and 20X2:
A
B
C
(A+B)*C
Risk of default
Risk of default
Loss that would
Lifetime expected
in next 12 months in months 13-36
result from default
credit losses
CUCU
At 1 July 20X12.5%
5.0%
800,000
60,000
At 31 Dec 20X13.0%
10.0%
700,000
91,000
At 31 Dec 20X21.0%
2.0%
500,000
15,000
Note that the probability that there will be no default is implicit in the percentages above.
Note also that the loss that will transpire should a loss occur in the event of default in the next
12 months does not correspond to the expected cash shortfalls in the next 12 months.
What credit loss provision should Entity B book at:
(i) 1 July 20X1
(ii) 31 December 20X1
(iii)31 December 20X2
Solution
At 1 July 20X1:
On initial recognition Entity B should recognise a credit loss provision equivalent to 12-month
expected losses.
12-month expected loss = (2.5% * CU800,000] = CU20,000
At 31 December 20X1:
Entity B first evaluates whether credit risk has increased significantly since the loan was
initially recognised (on 1 July 20X1). If Entity B has chosen to use the practical expedient
for low credit risk, it also evaluates whether the absolute level of credit risk is low. The
evaluations are as follows:
• credit risk relative to initial recognition? The total risk of default has increased from 7.5%
to 13.0% which is clearly significant
• is absolute level of credit risk ‘low’? Although ‘low’ is not quantified, a 13.0% risk of default
certainly appears to not be low. IFRS 9 B.5.5.23 refers to an example of low credit risk
being an external rating of ‘investment grade’. The lowest rating generally considered
investment grade is ‘BBB’ meaning adequate capacity to meet financial commitments.
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The impairment requirements
The credit loss provision should therefore be based on lifetime expected losses.
Lifetime expected loss = (3.0%+10%) * CU700,000 = CU91,000
At 31 December 20X2:
Entity B again evaluates whether credit risk has increased significantly since 1 July 20X1.
If Entity A has chosen to use the practical expedient for low credit risk, it also evaluates
whether the absolute level of credit risk is low. The evaluations are as follows
•
credit risk relative to initial recognition? The total risk of default has now decreased to
3.0% and is therefore lower than the risk at initial recognition of 7.5%
• is absolute level of credit risk ‘low’? This evaluation is not relevant given there has not been a
significant increase in the instrument’s credit risk compared to the level at initial recognition.
The credit loss provision should therefore return to being based on 12-month
expected losses.
12-month expected loss = (1.0% * CU500,000) = CU5,000
Determining whether there has been a
significant increase in the credit risk of a
financial instrument is therefore key to
applying the Standard’s impairment
requirements. We discuss this below.
3.2.1 Identifying a significant
increase in credit risk
Subject to the ‘low credit risk’ operational
simplification, IFRS 9 requires that the
credit losses estimate switches from
12-month expected credit losses to
lifetime expected credit losses when
credit risk has increased significantly
since initial recognition. If the level of
credit risk reduces in a later period, such
that the level of credit risk is no longer
significantly higher, the credit losses
estimate switches back to 12-month
expected credit losses. The assessment
of whether there has been a significant
deterioration in the credit risk of a
financial instrument is therefore key.
To make this assessment an entity
compares the risk of a default occurring
on the financial instrument as at the
reporting date with the same risk as at
the date of initial recognition, considering
reasonable and supportable information
that is indicative of significant increases
in credit risk since initial recognition.
3.2.1.1 Definition of default
IFRS 9 explains that changes in credit
risk are assessed based on changes in
the risk of a default occurring over the
expected life of the financial instrument
(the assessment is not based on the
amount of expected losses). ‘Default’ is
not itself actually defined in IFRS 9
however. Companies must instead reach
their own definition and IFRS 9 provides
guidance on how to do this.
The Standard states that when
defining default, an entity shall apply a
default definition that is consistent with
the definition used for internal credit risk
management purposes for the relevant
financial instrument and consider
qualitative indicators (for example,
financial covenants) when appropriate.
However, there is a ‘rebuttable
presumption’ that default does not occur
later than when a financial asset is
90 days past due unless an entity has
reasonable and supportable information
to demonstrate that a more lagging
default criterion is more appropriate.
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Practical insight – defining ‘default’
Not every entity needs to define ‘default’. For example, an entity whose credit
exposures are limited to trade receivables and contract assets (with no
significant financing component) would apply the simplified model described
in section 4.
However, ‘default’ is a key building block when applying the general
(three-stage) model because:
•movement between the three stages is driven by changes in the risk
of default
•some entities estimate credit losses as the product of the probabilities of
various defaults (PDs) and the losses that would arise if those defaults occur
(‘loss given default’ or LGD)
Once determined, the definition shall be
applied consistently to all financial
instruments unless information becomes
available that shows another definition
is more appropriate for a particular
financial instrument.
Definitions of default used in practice fall into two very broad categories:
•definitions based on contractual breaches such as failure to make a
payment when due or breaches of a covenant
•more judgemental definitions based on qualitative factors.
The most important point is that the definition should be appropriate to the
instrument. This is best explained by examples:
Example 1 – instalment loan
Lender A makes a 5 year amortising loan with payments of principal and
interest payable in regular monthly instalments. The borrower is also subject
to six-month financial covenants.
For this loan a definition of default based on missed payments and covenant
breaches could be suitable.
Example 2 – term loan
Lender B makes a 5 year loan with interest payable monthly and principal all
due on maturity.
In this case it is unlikely that a definition of default that is based solely on
missed payments will be sufficient. This is because the main repayment is
not due until maturity and hence a definition based on late payment would not
capture the possibility that events take place before maturity that result in the
borrower becoming unlikely to repay.
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The impairment requirements
Practical insight – interaction with regulatory definitions of default
Some entities such as financial institutions may be the subject of regulation which is designed to gauge their solvency.
The regulations affecting such entities will often contain a definition of default. This leads to the question of whether the
regulatory definition can be used for IFRS 9 purposes.
The simple answer to this question is that regulatory definitions of default can be used in so far as they do not conflict with
the principles set out in IFRS 9.
Example
An entity might wish to use a local regulator’s definition of ‘non-performing loans’ for determining when it needs to transfer
assets into and out of Stage 3 of IFRS 9’s impairment model. Under the local regulator’s rules, a loan cannot be transferred
back to the portfolio of performing loans until at least 12 months have elapsed from the point it was categorised as nonperforming. Can the regulator’s definition of non-performing loans be used as the basis for making transfers into and out of
Stage 3 of IFRS 9’s impairment model?
The regulator’s definition of non-performing loans may not be appropriate for IFRS 9 purposes. IFRS 9 would require the
asset to be transferred out of stage 3 if the credit risk on the financial instrument improves so that the financial asset is no
longer credit-impaired. There is nothing in IFRS 9 to prohibit the transfer out of stage 3 occurring sooner than 12 months
after the transfer into stage 3. The regulatory definition of non-performing loans may be a useful starting point in arriving at
a definition of default, but will probably need to be amended to comply with IFRS 9.
3.2.1.2 Interaction with the level of credit
risk on initial recognition
Applying the three-stage model requires
calibrating the level of credit risk of
financial assets at initial recognition. This
becomes the reference point at each
future reporting date. If the credit risk
has increased, the next key assessment
is to determine whether or not the
increase is significant.
A given increase in credit risk is more
likely to be significant for a financial
instrument with a lower credit risk at
initial recognition.
Practical insight – effect of business combinations
When financial assets are acquired in a business combination, the reference
point for measuring the initial level of credit risk of those assets is reset to the
date of the business combination.
Example
Entity C acquired Entity D in a business combination in June 2014. Entity D
holds a loan from an associate that was considered low credit risk when first
advanced in 2012. In June 2014, the risk of default on this loan was considered
to be significant. At the reporting date of December 2014, the risk of default
remains the same as at June 2014. Has there been a significant increase in
credit risk at the reporting date of December 2014?
No. The date of the business combination is the reference date for the
acquirer’s financial statements, not the acquiree’s date of initial recognition.
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3.2.1.3 Interaction with the length to
maturity of an instrument
3.2.1.4 Reasonable and supportable
information
3.2.1.5 Rebuttable presumption for
payments more than 30 days past due
The risk of a default occurring on
financial instruments that have
comparable credit risk is higher the
longer the expected life of the instrument.
For example, the risk of a default
occurring on an asset with an expected
life of 20 years is higher than that on an
otherwise identical asset that has an
expected life of 10 years.
The change in credit risk cannot be
assessed simply by comparing the
change in the absolute risk of a default
occurring over time. For example, if the
risk of a default occurring for a financial
instrument with an expected life of
20 years at initial recognition is identical
to the risk of a default occurring on that
financial instrument when its expected life
in a subsequent period is only five years,
that may indicate an increase in credit
risk. This is because the risk of a default
occurring generally decreases as time
passes if the credit risk is unchanged
and the financial instrument is closer to
maturity. This may not be the case
however for financial assets that only
have significant payment obligations
close to the maturity of the asset. For
such assets, the risk of a default
occurring may not necessarily
decrease as time passes.
An entity should use ‘reasonable and
supportable information that is available
without undue cost or effort’ to determine
whether credit risk has increased
significantly. This should typically include
forward-looking information as well as
historical data such as past due status.
This reflects the fact that typically,
credit risk increases significantly before a
financial instrument becomes past due
(NB this holds true for other borrowerspecific factors such as modifications
or restructurings).
However when forward-looking
information is not available without undue
cost or effort, an entity may use past due
information to determine whether there
have been significant increases in credit
risk since initial recognition.
Regardless of the way in which an entity
assesses significant increases in credit
risk, there is a rebuttable presumption
that the credit risk of a financial asset has
increased significantly since initial
recognition when contractual payments
are more than 30 days past due.
The presumption can be rebutted only
when the reporting entity has reasonable
and supportable information available that
demonstrates that 30 days past due
does not represent a significant increase
in the credit risk of a financial instrument.
For example historical evidence might
demonstrate that there is no significant
correlation between the risk of a default
occurring and financial assets becoming
more than 30 days past due. Instead,
a correlation might be observable only
once payments are say more than
45 days past due.
The presumption does not apply when
an entity determines that there have been
significant increases in credit risk before
contractual payments are more than
30 days past due.
An entity should use ‘reasonable and supportable information
that is available without undue cost or effort’ to determine
whether credit risk has increased significantly. This should
typically include forward-looking information as well as
historical data.
14 Issue 2 March 2016
The impairment requirements
3.2.1.6 Multi-factor analysis
IFRS 9 states that the analysis of credit
risk is a multi-factor and holistic analysis.
This means that determining whether a
specific factor is relevant, and the weight
it should be given compared to other
factors in the overall assessment, will
depend on the type of product,
characteristics of the financial
instruments and the borrower as
well as the geographical region.
3.2.1.7 Individual or collective
assessment
Depending on the nature of the financial
instrument and the information available
about its credit risk, it may not be
possible (without undue cost or effort) to
identify significant changes in credit risk
at individual instrument level before the
financial instrument becomes past due. It
may therefore be necessary to assess
significant increases in credit risk on a
collective or portfolio basis.
Practical insight – shared credit risk characteristics
The Standard gives the following, non-exhaustive list of examples of possible
shared credit risk characteristics:
• instrument type
• credit risk ratings
• collateral type
• date of initial recognition
• remaining term to maturity
•industry
• geographical location of the borrower
•the value of collateral relative to the financial asset if it has an impact on the
probability of a default occurring.
This is particularly relevant to financial
institutions with a large number of
relatively small exposures such as retail
loans. In practice, the lender may not
obtain or monitor forward-looking credit
information about each customer. In such
cases the lender would assess changes
in credit risk for appropriate portfolios,
groups of portfolios or portions of a
portfolio of financial instruments. Any
instruments that are assessed collectively
must possess shared credit risk
characteristics. This is to prevent
significant increases in credit risk being
obscured by aggregating instruments
that have different risks.
There is a rebuttable presumption that the credit risk
of a financial asset has increased significantly since initial
recognition when contractual payments are more than
30 days past due.
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When instruments are assessed
collectively, it is important to remember
that the aggregation may need to
change over time as new information
becomes available.
Practical insight – information that may be relevant in assessing changes
in credit risk
You may wish to consider the following in assessing changes in credit risk. The
list is not intended to be exhaustive.
•significant changes in internal price indicators of credit risk
•changes in the terms of an instrument that reflect changes in credit risk (eg
more stringent covenants)
•significant changes in external market indicators of credit risk (eg the length
of time or extent to which a financial asset has been below amortised cost)
•existing or expected adverse changes in the regulatory, economic, or
technological environment that significantly affect, or are expected to affect,
the borrower’s ability to meet its debt obligations
•
an actual or expected significant change in the operating results of the borrower
•significant changes in the value of the collateral supporting the obligation or
in the quality of guarantees or credit enhancements
•reductions in financial support from a parent entity that are expected to
reduce the borrower’s incentive to make scheduled contractual payments
•expected breaches of contract that may, for example, lead to covenant
waivers or amendments, or interest payment holidays
•
significant changes in the expected performance and behaviour of the borrower
• past due information.
The analysis of credit risk is a multi-factor and holistic
analysis. Determining whether a specific factor is relevant
and the weight it should be given will depend on the type
of product, characteristics of the financial instruments and
the borrower as well as the geographical region.
16 Issue 2 March 2016
The impairment requirements
3.3 Measuring expected
credit losses
Possible sources of data to use in assessing significant increases in
credit risk’
IFRS 9 defines expected credit losses as
“the weighted average of credit losses
with the respective risks of a default
occurring as the weights”. In other
words, expected credit losses are a
probability-weighted estimate of credit
losses (ie the present value of all cash
shortfalls) over the expected life of the
financial instrument.
Internal data
• significant changes in
– internal price indicators
– changes in other rates or terms
• actual or expected downgrade to internal credit rating or behaviour score
• expected changes in loan documentation or expected breach of covenant
• past due information (see discussion above).
Borrower-specific external data
• significant changes in
– credit spread
– credit default swap (CDS) prices
– length of time fair value below cost
– other market information
• actual or expected downgrade to external credit rating
• increases in credit risk of borrower’s other instruments
• actual or expected deterioration in borrower’s financial performance.
3.3.1 General principles
IFRS 9 does not prescribe a particular
method of measuring expected credit
losses. The Standard instead
acknowledges that measurement might
vary based on the type of instrument in
concern and the information that is
available. It does however require that
any method that an entity uses to
measure credit losses should take into
account three ‘building blocks’.
Broader external data
• adverse changes (actual or expected) in borrower’s
– financial performance
– business, financial or economic conditions
– regulatory, economic or technological environment
• adverse changes in value or quality of any
– supporting collateral
– shareholder guarantee or financial support.
Three key building blocks:
•an unbiased and probabilityweighted amount that is
determined by evaluating a range
of possible outcomes
•the time value of money
•reasonable and supportable
information about past events,
current conditions and forecasts
of future economic conditions.
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We discuss each building block in
turn below.
3.3.2 Probability-weighted amount
IFRS 9 requires the estimate of expected
credit losses to reflect an unbiased and
probability-weighted amount that is
determined by evaluating a range of
possible outcomes.
In doing this, the purpose is neither to
estimate a worst-case scenario nor to
estimate the best-case scenario. An
estimate of expected credit losses shall
however always reflect the possibility that
a credit loss occurs and the possibility
that no credit loss occurs even if the
most likely outcome is no credit loss.
The Standard notes that in practice, a
complex analysis may not be needed in
order to arrive at the probability-weighted
outcome. In some cases, relatively
simple modelling may be sufficient,
without the need for a large number of
detailed simulations of scenarios. For
example, the average credit losses of a
large group of financial instruments with
shared risk characteristics may be a
reasonable estimate of the probabilityweighted amount. In other situations, the
identification of scenarios that specify the
amount and timing of the cash flows for
particular outcomes and the estimated
probability of those outcomes will
probably be needed. If this is the case,
then the analysis must reflect at least the
possibility that a credit loss occurs and
the possibility that no credit loss occurs.
18 Issue 2 March 2016
3.3.3 Time value of money
IFRS 9 requires expected credit losses to be discounted to the reporting date using
the effective interest rate determined at initial recognition or an approximation of it.
The table sets out the discount rates to be used for different types of financial
instrument.
Discount rates to be used for different types of financial instrument
Instrument
Discount rate to be used
Fixed rate assets
•
effective interest rate determined at initial recognition
Variable rate assets
•
current effective interest rate
Purchased or originated credit-
•
credit-adjusted effective interest rate determined at initial recognition
impaired financial assets
Lease receivables
•same discount rate as used in the measurement of the
lease receivable
Loan commitments
•effective interest rate, or an approximation of it, that will be
applied when recognising the financial asset resulting from the
loan commitment
Loan commitments for which
•a rate that reflects the current market assessment of the time
the effective interest rate
value of money and the risks specific to the cash flows (unless
cannot be determined
adjustment has instead been made to the cash shortfalls)
Financial guarantee contracts
•a rate that reflects the current market assessment of the time
value of money and the risks specific to the cash flows (unless
adjustment has instead been made to the cash shortfalls)
The impairment requirements
3.3.4 Reasonable and supportable
information
Reasonable and supportable information
is that which is reasonably available at
the reporting date without undue cost or
effort, including information about past
events, current conditions and forecasts
of future economic conditions.
The information used is required to
reflect factors that are specific to the
borrower, general economic conditions and
an assessment of both the current as well
as the forecast direction of conditions at
the reporting date. Information that is
available for financial reporting purposes is
always considered to be available without
undue cost or effort.
An entity is not required to
incorporate forecasts of future conditions
over the entire expected life of a financial
instrument. Neither is a detailed estimate
of expected credit losses needed for
periods that are far in the future. Instead
an entity may extrapolate projections
from available, detailed information for
such periods.
Possible data sources
•internal historical credit
loss experience
•internal ratings
•credit loss experience of
other entities
•external ratings, reports
and statistics.
Where an entity does not have
sufficient sources of entity-specific
data of its own, it may use peer
group experience for comparable
financial instruments.
Historical information is a useful base
from which to measure expected credit
losses but may need to be adjusted to
reflect current conditions. For example,
estimates of changes in expected credit
losses should reflect and be directionally
consistent with changes in related
observable data from period to period
and in the magnitude of those changes.
Examples include changes in:
• unemployment rates
• property prices
• commodity prices
• payment status or
•other factors indicative of credit
losses on the instrument.
As discussed in earlier sections, an entity
is required to recognise either lifetime
expected credit losses or 12-month
expected credit losses depending on the
particular circumstances of the
instrument in concern.
An entity may use practical
expedients when measuring expected
credit losses if they are consistent with
IFRS 9’s principles. An example of a
practical expedient is the calculation of
the expected credit losses on trade
receivables using a provision matrix (see
section 4.2).
IFRS 9 explains that a credit loss
arises even if the entity expects to be
paid in full but at a later time than when
contractually due. This follows from the
fact that expected credit losses consider
the timing of payments as well as the
cash shortfalls.
IFRS 9 requires the estimate of expected credit losses to
reflect an unbiased and probability-weighted amount that
is determined by evaluating a range of possible outcomes.
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3.3.5 Measurement of expected
credit losses for different types of
asset/exposure
The table opposite illustrates how the
principles for the measurement of credit
losses apply to various different types of
asset/exposure.
3.4 Application issues
3.4.1 Period to consider when
measuring expected credit losses
Entities are required to estimate cash
flows by considering all contractual terms
of the financial instrument (for example,
prepayment, extension, call and similar
options) through the expected life of that
financial instrument.
There is a presumption that the
expected life of a financial instrument can
be estimated reliably. However, in those
rare cases when it is not possible to
reliably estimate the expected life of a
financial instrument, the entity shall use
the remaining contractual term of the
financial instrument.
For the purpose of measuring
expected credit losses, IFRS 9 states
that the maximum period to consider is
the maximum contractual period
(including borrower extension options)
over which the entity is exposed to credit
risk. In some cases an entity might
expect to be exposed to credit risk over
a longer period than the contractual
period – for example if it expects to
extend the loan term even though it has
no obligation to do so. However, subject
to the limited exception for credit card
and similar facilities (see practical insight
box below), the measurement period is
limited to the contractual period even
though a longer period may be consistent
with business practice.
20 Issue 2 March 2016
Principles for the measurement of credit losses
Type of instrument
Measurement of credit losses
Financial assets (that are not
Present value of the difference between
credit-impaired)
•
the contractual cash flows due under the contract
•
the cash flows expected to be received
Credit-impaired financial
Expected credit losses are the difference between
assets (that are not purchased
•
or originated credit-impaired
•the present value of estimated cash flows discounted at the financial
financial assets*)
Undrawn loan commitments
the asset’s gross carrying amount
asset’s original effective interest rate
Present value of the difference between
•the contractual cash flows that are due to the entity if the holder
of the loan commitment draws down the loan
•the cash flows that the entity expects to receive if the loan is
drawn down
Financial guarantee contracts
Cash shortfalls are the expected payments to reimburse the holder for
a credit loss that it incurs less any amounts that the entity expects to
receive from the holder, the debtor or any other party.
* purchased or originated credit-impaired financial assets are excluded as the general approach to impairment
is not applied to them (impairment is always based on lifetime expected credit losses and the estimate of such
losses on initial recognition is reflected in a credit-adjusted effective interest rate).
Example – measurement period
Entity E makes a 12-month loan to Entity F. The contract states that the loan
can be extended for a further 6 months at the sole option of Entity E (the
lender). Entity E’s management considers that it is probable that the loan will
be extended. It is assumed that the loan meets IFRS 9’s ‘solely payments of
principal and interest’ condition to be measured at amortised cost.
In this example, the expected losses would be measured based on the
12-month contractual term. The measurement would not take into account
possible future losses arising from management’s decision to extend the loan
for the additional 6 month period, unless or until the extension option is actually
exercised. This is because the extension is at the sole option of the lender, so
12 months is the maximum contractual period over which the lender is exposed
to credit risk.
If Entity F (the borrower) has the right to extend the loan however, the
maximum contractual credit risk period would be 18 months.
The impairment requirements
For loan commitments and financial
guarantee contracts, the maximum
contractual period is the period over
which an entity has a present contractual
obligation to extend credit.
3.4.2 Collateral
While the existence of collateral plays a
limited role in the assessment of whether
there has been a significant increase in
credit risk, it is very relevant to the
measurement of expected credit losses.
IFRS 9 states that the estimate of
expected cash shortfalls reflects the cash
flows expected from collateral and other
credit enhancements that are integral to
the instrument’s contractual terms.
The estimate of expected cash
shortfalls on a collateralised financial
instrument reflects
•the amount and timing of cash flows
that are expected from foreclosure
on the collateral
•less the costs of obtaining and selling
the collateral.
This is irrespective of whether or not
foreclosure is probable. In other words,
the estimate of expected cash flows
considers both the probability of a
foreclosure and the cash flows that would
result from it. A consequence of this is
that any cash flows that are expected
from the realisation of the collateral
beyond the contractual maturity of the
contract are included in the analysis. This
is not to say that the entity is required to
assume that recovery will be through
foreclosure only however. Instead the
entity should calculate the cash flows
arising from the various ways in which the
asset might be recovered and assign
probability-weightings to those outcomes
(see also section 3.3.2).
Practical insight – credit card and similar facilities
Some financial instruments include both a loan and an undrawn commitment
component, with the effect that the entity’s contractual ability to demand
repayment and cancel the undrawn commitment does not limit the entity’s
exposure to credit losses to the contractual notice period. Examples are
revolving credit facilities, such as credit cards and overdraft facilities, which can
be contractually withdrawn by the lender with as little as one day’s notice.
In practice lenders continue to extend credit for a longer period in such
situations. The consequence of this is that the lender may frequently withdraw
the facility only after the credit risk of the borrower increases, which could be too
late to prevent some or all of the expected credit losses. IFRS 9 contains specific
guidance for such arrangements stating that the entity shall measure expected
credit losses over the period that the entity is exposed to credit risk and expected
credit losses would not be mitigated by credit risk management actions, even
though the period may extend beyond the maximum contractual period.
The Standard notes that when determining the period over which the entity is
exposed to credit risk, the entity should consider factors such as relevant historical
information and experience on similar financial instruments. This guidance, which is
narrowly scoped, should not be applied by analogy to other instruments.
3.5 Practical expedients
3.5.1 ‘Low credit risk’ exception
As a practical measure, IFRS 9 states
that an entity may assume that the credit
risk on a financial instrument has not
increased significantly since initial
recognition if the financial instrument is
determined to have low credit risk at the
reporting date. This is an optional
simplification. It is designed to relieve
entities from tracking changes in the
credit risk of high quality assets. This
election can be made on an instrument
by instrument basis.
Practical insight – what is ‘low’
credit risk?
IFRS 9 does not define ‘low’ credit
risk. It does state that the credit
risk on a financial instrument is
considered low for the purpose of
IFRS 9, if:
•the financial instrument has a
low risk of default
•the borrower has a strong
capacity to meet its contractual
cash flow obligations in the near
term and
• adverse changes in economic
and business conditions in the
longer term may, but will not
necessarily, reduce the ability
of the borrower to fulfil its
contractual cash flow obligations.
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To determine whether a financial
instrument has low credit risk, an entity
may use its internal credit risk ratings or
other methodologies that are consistent
with a globally understood definition of
low credit risk and that consider the risks
and the type of financial instruments that
are being assessed. An external rating of
‘investment grade’ is an example of a
financial instrument that may be
considered as having low credit risk.
Practical insight – impact on
corporates
Corporate entities that hold
externally rated debt instruments
are likely to rely on external rating
agencies data when using the
low credit risk simplification. It is
important to realise however that in
some situations adjustments may
be needed to these ratings. For
example during the financial crisis, it
was evident that some ratings were
lagging behind the times and did not
reflect current market conditions.
In order to conclude that an
instrument with an external rating
equivalent to ‘investment grade’ has
low credit risk, IFRS 9 therefore
requires an entity to consider
whether an external rating is
determined using methodologies
that are consistent with a globally
understood definition of low credit
risk and whether there is evidence
of an increase in credit risk that is
not yet reflected in the rating.
22 Issue 2 March 2016
An asset is not considered to have low
credit risk simply because it has
•a low risk of loss
•a lower risk of default than other
assets that the entity holds
•a lower risk of default relative to the
credit risk of the jurisdiction in which
the entity operates.
Where an entity opts to use the
simplification and an instrument is deemed
to have low credit risk, a loss allowance is
recognised based on 12-month expected
credit losses. When an instrument is no
longer considered to have low credit risk
then the general requirements for
assessing whether there has been a
significant increase in credit risk apply.
3.5.2 Other practical expedients
In addition to the low credit risk
exception described above, IFRS 9
contains a number of other practical
expedients and simplifications:
IFRS 9 expedients and simplifications
Practical expedient or simplification
Reference within this guide
Rebuttable presumption that default does not occur later than when a
See section 3.2.1.1
financial asset is 90 days past due
Rebuttable presumption that the credit risk on a financial asset has
See section 3.2.1.5
increased significantly since initial recognition when contractual payments
are more than 30 days past due
Simplified approach for trade receivables and contract assets of one year
See section 4.1
or less or ones that do not contain a significant financing component
Option of applying the simplified approach for trade receivables
See section 4.1
and contract assets which do contain a financing component
Option of applying the simplified approach for lease receivables
See section 4.1
Use of provision matrices when applying the simplified model for
See section 4.2
trade receivables
1
1
1
1
1
1
1
1
4. Simplified model for trade
receivables, contract assets
and lease receivables
In developing IFRS 9’s impairment requirements, there was concern that the process of
determining whether to recognise 12-month or lifetime expected credit losses was not
justifiable for instruments such as trade receivables and lease receivables.
The IASB has therefore included a number of simplifications which are explained in this
section.
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As discussed on the previous page, the IASB decided that the three-stage approach
described in section 3 was too complex for certain types of assets. Set out below is an
overview of the simplifications the IASB made in finalising the Standard.
4.1 Overview
IFRS 9 includes the following simplifications:
Situation
Simplification
Trade receivables and contract assets of one year
Always recognise a loss allowance at an amount
or less or ones which do not contain a significant
equal to lifetime expected credit losses
financing component
Trade receivables and contract assets which
Entities are allowed to choose to always recognise
do contain a significant financing component (in
a loss allowance at an amount equal to lifetime
accordance with IFRS 15)
expected credit losses
Lease receivables within the scope of IAS 17
An entity is similarly allowed to choose as its
accounting policy to measure the loss allowance at
an amount equal to lifetime expected credit losses.
The accounting policy choice applies
independently for trade receivables with
a significant financing component, lease
receivables and contract assets with a
significant financing component.
A key advantage of the simplified
approach is that an entity is not required
to determine whether credit risk has
increased significantly since initial
recognition. Instead a loss allowance
is recognised based on lifetime expected
credit losses at each reporting date.
Using the simplified approach means an entity is not
required to determine whether credit risk has increased
significantly since initial recognition.
24 Issue 2 March 2016
The impairment requirements
Practical insight – determining whether there is a significant financing
component under IFRS 15
To determine whether a financing component is significant under IFRS 15, an
entity considers several factors, including, but not limited to, the following:
•the difference, if any, between the promised consideration and the
cash price
•the combined effect of:
−the expected length of time between delivery of the goods or services
and receipt of payment
− the prevailing interest rates in the relevant market.
A contract may not have a significant financing component if:
•advance payments have been made but the transfer of the good or service
is at the customer’s discretion
•the consideration is variable based on factors outside the vendor’s and
customer’s control (eg a sales-based royalty)
•a difference between the promised consideration and the cash price relates
to something other than financing such as protecting one of the parties from
non-performance by the other.
As a practical expedient, an entity can ignore the impact of the time value
of money on a contract if it expects, at contract inception, that the period
between the delivery of goods or services and customer payment will be one
year or less.
Practical insight – contract assets
‘Contract asset’ is a term introduced by the new revenue recognition
standard (IFRS 15 ‘Revenue from Contracts with Customers’). IFRS 15
provides a detailed definition but contract assets are broadly equivalent to
unbilled revenue.
Even though contract assets are not financial assets, and are accounted
for mainly under IFRS 15, IFRS 9’s impairment requirements apply to them.
This means that when entities recognise revenue in advance of being paid or
recording a receivable, they also need to recognise an expected credit loss.
4.2 Applying the simplified model
IFRS 9 does not prescribe how an entity
should estimate lifetime expected credit
losses when applying the simplified
model. The Standard does however
permit the use of practical expedients
and refers to the example of a ‘provision
matrix’. We anticipate that this approach
will be widely applied.
In devising such a provision matrix, an
entity would use its historical credit loss
experience (adjusted as necessary to
reflect current conditions) for trade
receivables to estimate the 12-month
expected credit losses or the lifetime
expected credit losses on the financial
assets as relevant. This might be done,
for example, by specifying fixed provision
rates depending on the number of days
that a trade receivable is past due.
Depending on the diversity of its
customer base, it might also be
necessary for the entity to segregate the
trade receivables. This would be the case
for example if the entity’s historical credit
loss experience shows significantly
different loss patterns for different
customer segments.
Segregating trade receivables
The following are some examples
of criteria that might be used to
group assets:
•geographical region
• product type
• customer rating
•collateral or trade credit
insurance
• type of customer.
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Example
Company E, a manufacturer, has trade receivables of CU100 million in 20X1 representing
balances from a large number of small clients.
The trade receivables do not have a significant financing component and are accordingly
measured for impairment purposes at an amount equal to lifetime expected credit losses.
Company E operates in only one geographical region.
Company E uses a provision matrix to determine expected credit losses on the
receivables. The provision matrix is based on historical observed default rates over the
expected life of the trade receivables, adjusted for forward-looking estimates such as the
deterioration in economic conditions expected by Company E in the coming year. This
process results in the following provision rates which are based on the number of days that a
trade receivable is past due:
Current
1-30 days 31-60 days 61-90 days More than 90
past due
past due
past due days past due
Lifetime expected 0.2%1.1%3.9%7.5% 9.2%
credit loss rate
These percentages are then applied in the provision matrix as follows:
Lifetime expected
Gross carrying Lifetime expected
credit loss rate
amount of trade credit losses (gross
receivables
carrying amount of
trade receivables x
lifetime expected
credit loss rate)
%CU CU
Current balances 0.2%
40,000,000
80,000
Balances 1-30 days past due
1.1%
28,000,000
308,000
Balances 31-60 days past due
3.9%
19,000,000
741,000
Balances 61-90 days past due
7.5%
10,000,000
750,000
Balances more than 90 days past due
9.2%
3,000,000
276,000
100,000,0002,155,000
With reference to the disclosure requirements added by IFRS 9 to IFRS 7 ‘Financial
Instruments: Disclosures’ (see section 7), such a provision matrix could also form the basis
of a risk profile disclosure.
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The impairment requirements
Practical insight – building a provision matrix
As noted, IFRS 9 permits entities to use ‘practical expedients’. A provision matrix is one example. However, there is no
further guidance on other possible expedients or on how to implement a provision matrix in practice.
There is no ‘one size fits all’ approach to this: each entity will need to consider its own circumstances, including the
materiality of expected losses and the data available (without undue cost or effort).
Single loss-rate approach
Fortunately, many businesses experience low levels of bad debts. In practice, however, few companies will be able to
demonstrate that ECLs are so immaterial that no calculations or loss reserves are required at all. Nonetheless, for some
companies applying a single loss-rate to receivables or groups of receivables might be appropriate. For example, an
entity might determine an average historical loss rate by comparing the total balance of trade receivables at various past
dates and determining the amounts collected/not collected. This would then be adjusted as necessary to reflect changes
in circumstances.
Provision matrix
In other cases a provision matrix or other more sophisticated approach will be necessary. The idea behind a provision
matrix is to estimate expected credit losses (ECLs) based on the ‘age’ of receivables. Accordingly, the operational
challenge is to determine the relationship between the age of your receivables and the risk of non-payment. In order to
‘build’ a provision matrix the typical steps will be:
1 segregate receivables into appropriate groups
2 within each group, determine:
aage-bands
b historical back-testing dates (data points)
3 for each age-band, at each back-testing date determine:
a the gross receivables
bthe amounts ultimately collected/written-off. If material, adjustments should be made to exclude the effect of
non-collections for reasons other than credit loss (eg credit notes issued for returns, short-deliveries or as a
commercial price concession)
4 compute average historical loss rate by age-band
5 adjust historical loss rates if necessary, eg to take account of changes in:
aeconomic conditions
btypes of customer
ccredit management practices
6consider whether ECLs should be estimated individually for any period-end receivables, eg because specific information
is available about those debtors
7 apply loss rate estimates to each age-band for the other receivables in this group.
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Issue 2 March 2016 27
5. Purchased or originated
credit-impaired financial
assets
IFRS 9 contains a specific approach for assets that are credit impaired at the date of
initial recognition. Under this approach, which differs from IFRS 9’s general model for
impairment, entities:
•apply the credit-adjusted effective interest rate to the asset’s amortised cost from
initial recognition
•subsequently recognise the cumulative changes in lifetime expected credit losses
•gains are not limited to the reversal of previously recognised losses as they are
for other assets.
This section explains the requirements in more depth. It ends with a diagramme
summarising how the approach for credit impaired assets and the simplified model
for trade and lease receivables described in section 4, interact with the general
model described in section 3.
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The impairment requirements
IFRS 9 contains a specific approach for purchased or originated credit-impaired financial
assets (assets that are credit impaired at the date of initial recognition) which differs
from the general model for financial assets.
Under this specific approach, an entity is
required to apply the credit-adjusted
effective interest rate to the amortised
cost of the financial asset from initial
recognition. Thereafter it only recognises
the cumulative changes in lifetime
expected credit losses since initial
recognition as a loss allowance. The
amount of the change in lifetime
expected credit losses is recognised
in profit or loss as an impairment
gain or loss.
Unlike other financial assets, gains on
purchased or originated credit-impaired
assets are not limited to the reversal of
previously recognised impairment losses.
Instead an improvement in credit quality
beyond that which was estimated at the
time of initial recognition, results in
impairment gains being recognised in
profit or loss.
Definition of a credit-impaired financial asset
IFRS 9 states that a financial asset is credit-impaired when one or more events
that have a detrimental impact on the estimated future cash flows of that
financial asset have occurred.
Evidence that a financial asset is credit-impaired include observable data
about the following events:
•significant financial difficulty of the issuer or the borrower
•a breach of contract, such as a default or past due event
•the lender(s), for economic or contractual reasons relating to the borrower’s
financial difficulty, having granted to the borrower a concession(s) that the
lender(s) would not otherwise consider
•it is becoming probable that the borrower will enter bankruptcy or other
financial reorganisation
•the disappearance of an active market for the financial asset because of
financial difficulties
•the purchase or origination of a financial asset at a deep discount that
reflects the incurred credit losses.
The Standard notes that it may not be possible to identify a single discrete
event – instead, the combined effect of several events may have caused
financial assets to become credit-impaired.
Unlike other financial assets, gains on purchased or
originated credit-impaired assets are not limited to the
reversal of previously recognised impairment losses.
Issue 2 March 2016 29
Get ready for IFRS 9
The following diagramme summarises the
interaction of the exceptions discussed in
sections 4 and 5 with the general model
discussed in section 3.
Decision tree for expected credit losses
Is the asset credit impaired at initial recognition?
Recognise change in lifetime
Yes
expected credit losses
No
Is the asset a trade receivable/contract asset with a significant financing
component/lease receivable, for which the lifetime expected credit loss
measurement has been elected?
Yes
No
Is the asset a trade receivable/contract asset without a significant financing
component?
Yes
Recognise lifetime expected
credit losses
No
Has there been a significant
increase in credit risk since initial
recognition?
Yes
Is the absolute level of credit risk
low, and has the entity elected to
use the low credit risk operational
simplification?
No
Yes
No
Recognise 12-month expected credit losses
The specific approach for purchased or originated
credit-impaired financial assets, and the simplified
model for trade receivables, contract assets and
lease receivables, differ from IFRS 9’s general model.
30 Issue 2 March 2016
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6. Presenting credit losses
The classification of a financial asset does not impact on the presentation of the loss
allowance in profit or loss but it does impact on the presentation in the statement of
financial position.
This section explains the requirements and provides guidance on fulfilling them.
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Get ready for IFRS 9
Measurement of impairment losses is the same whether a financial asset is measured at
amortised cost or is a debt-type instrument measured at fair value through other
comprehensive income. In both cases, the amount of expected credit losses (or
reversal) required to adjust the ‘loss allowance’ at the reporting date to the amount
required under the Standard is recognised in profit or loss. The classification of the
financial asset does however have an impact on the presentation of expected credit
losses in the statement of financial position.
6.1 Financial assets measured at
amortised cost
For financial assets measured at
amortised cost in the statement of
financial position, the loss allowance
reduces the net carrying amount of
the asset.
In the event of a ‘write-off’, the entity
should directly reduce the asset’s gross
carrying amount. If the amount of loss on
write-off is greater than the accumulated
loss allowance, the difference represents
an additional impairment loss.
6.2 Financial assets measured at fair
value through other comprehensive
income
The measurement of debt-type financial
assets classified at fair value through
other comprehensive income (FVOCI) is a
combination of both amortised cost and
fair value measurement. As a result,
impairment gains and losses are
determined using the same methodology
that is applied to assets measured at
amortised cost.
32 Issue 2 March 2016
Practical insight – write-offs
IFRS 9 does not specify exactly when an asset is written off (ie derecognised).
The principle is however that a write-off occurs when there is ‘no reasonable
expectation’ of recovering either the entirety or a portion of an asset’s
contractual cash flows. Write-offs can relate to an entire asset or to part of it.
In practice many entities will need to develop a write-off policy that is
appropriate to their circumstances and to the different types of assets they
hold. Entities with relatively few financial assets might determine write-offs on a
case-by-case basis.
An appropriate write-off policy is important in order to avoid ‘grossing-up’
financial assets and related loss reserves when the assets are uncollectible.
Write-offs will also be important when analysing historical credit losses. This
is because entities need to determine the point at which assets become
uncollectible in order to determine past loss rates.
Because such assets are measured
in the statement of financial position at
fair value, the expected credit losses
recognised under IFRS 9 do not reduce
the carrying amount of the financial
assets in the statement of financial
position. Instead an accumulated
impairment amount is recognised in other
comprehensive income. This amount is
the same as the amount that would be
recognised if the asset had been
measured at amortised cost. In contrast
to assets measured at amortised cost
however, there is not a separate loss
allowance. Rather impairment gains or
losses are accounted for as an
adjustment of the revaluation reserve
relating to the asset that has been
accumulated in other comprehensive
income, with a corresponding charge to
profit or loss.
The impairment requirements
Example
Entity Y purchases a debt instrument on 1 July 20X0. The debt
instrument has a fair value of CU5,000 on initial recognition and
is measured at fair value through other comprehensive income.
The instrument has a contractual term of 10 years, and has both a
nominal and an effective interest rate of 5 per cent (for simplicity,
journal entries for interest revenue have not been given below).
The instrument is determined as not being credit-impaired on
initial recognition.
Practical insight – presentation of the loss
allowance in the primary statements
IFRS 9 introduced a consequential amendment
to IAS 1 ‘Presentation of Financial Statements’
which requires impairment losses to be shown
as a separate line item in the statement of
profit or loss, however no similar amendment
was made in respect of the statement of
financial position.
While IFRS 9 explicitly states that the loss
allowance for financial assets measured at fair
value through other comprehensive income
shall not reduce the carrying amount of the
financial asset in the statement of financial
position‚ the position is not clear for financial
assets measured at amortised cost. The
question of how an entity should present the
loss allowance for financial assets measured at
amortised cost was therefore referred to the
IFRS Transition Resource Group for Impairment
of Financial Instruments (ITG), a discussion
forum set up by the IASB to provide support
for stakeholders on implementation issues
following the issue of IFRS 9.
The issue was discussed at the ITG’s
December 2015 meeting. The view at this
meeting was that an entity is not required
to present the loss allowance in respect
of financial assets measured at amortised
cost separately in the statement of financial
position. An entity should however give
consideration to IAS 1’s general requirement
to present additional line items when this is
relevant to an understanding of the entity’s
financial position. Judgement will therefore be
needed in coming to a decision.
Accounting entries on initial recognition
Debit (CU)
Credit (CU)
Financial asset measured at FVOCI5,000
Cash5,000
Being recognition of the debt instrument at its fair value.
At the reporting date of 31 December 20X0, the fair value of the
debt instrument has declined to CU4,750 as a result of changes in
market interest rates. The entity determines that there has not been
a significant increase in credit risk since initial recognition. Expected
credit losses are therefore measured at an amount equal to
12-month expected credit losses, which amounts to CU150.
Accounting entries on 31 December 20X0
Debit (CU)
Credit (CU)
Impairment loss (profit or loss)
150
Other comprehensive income
100
Financial asset – FVOCI
250
Being recognition of 12-month expected credit losses and other fair value
changes on the debt instrument. Note that the cumulative loss in OCI of CU100
consists of the total fair value change of CU250 (CU5,000 - CU4,750) offset by
the accumulated impairment amount recognised of CU150.
On 1 January 20X1, the entity decides to sell the debt instrument for
CU4,750, which is its fair value at that date.
Accounting entries on 1 January 20X1
Debit (CU)
Credit (CU)
Cash
4,750
Financial asset – FVOCI
4,750
Loss (profit or loss)
100
Other comprehensive income
100
To derecognise the fair value through other comprehensive income asset and
recycle amounts accumulated in other comprehensive income to profit or loss.
Issue 2 March 2016 33
7. Disclosures
Given the significance of determining whether there has been an increase in credit risk
under IFRS 9’s new expected credit loss model, and the importance of impairment itself,
IFRS 9 has amended IFRS 7 extensively.
This section outlines the main areas of change.
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The impairment requirements
The disclosures added to IFRS 7 are intended to enable users of the financial statements
to understand the effect of credit risk on the amount, timing and uncertainty of future
cash flows.
To achieve this objective, credit risk
disclosures shall provide:
•information about an entity’s credit
risk management practices and how
they relate to the recognition and
measurement of expected credit
losses, including the methods,
assumptions and information used to
measure expected credit losses
•quantitative and qualitative information
that allows users of financial
statements to evaluate the amounts
in the financial statements arising
from expected credit losses, including
changes in the amount of expected
credit losses and the reasons for
those changes
•information about an entity’s credit
risk exposure (ie the credit risk
inherent in an entity’s financial assets
and commitments to extend credit)
including significant credit risk
concentrations.
Key disclosures
IFRS 7 has been amended to include both extensive qualitative and quantitative
disclosure requirements. Some of the more important disclosures include:
Qualitative disclosures
• inputs, assumptions and techniques used to:
−estimate expected credit losses (and changes in techniques or
assumptions)
−determine ‘significant increase in credit risk’ and the reporting entity’s
definition of ‘default’
− determine ‘credit-impaired’ assets
• write-off policies
•policies regarding the modification of contractual cash flows of
financial assets
•a narrative description of collateral held as security and other
credit enhancements.
Quantitative disclosures
• reconciliation of loss allowance accounts showing key drivers for change
• explanation of gross carrying amounts showing key drivers for change
• gross carrying amount per credit risk grade or delinquency
• write-offs, recoveries and modifications
•quantitative information about the collateral held as security and other credit
enhancements for credit-impaired assets.
Where information is presented
elsewhere, for example in a management
commentary that does not form part of
the financial statements, it is acceptable
to cross-reference to such documents in
order to avoid duplication.
In making their disclosures, entities
should consider factors such as:
• how much detail to disclose
•how much emphasis to place
on different aspects of the
disclosure requirements
•the appropriate level of aggregation
or disaggregation
•whether users of financial
statements need additional
explanations to evaluate the
quantitative information disclosed.
Issue 2 March 2016 35
8. Practical insight – next
steps
Although IFRS 9 (2014) only comes into mandatory effect for accounting periods beginning
on or after 1 January 2018, there are a number of actions you should consider taking now
in order to prepare for implementing the requirements.
This section sets out our recommendations. In particular we suggest you engage with your
auditors and business advisers now.
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The impairment requirements
While 2018 may seem a long way off, companies really need to start evaluating the
impact of IFRS 9 now. Set out below are the actions we recommend you undertake in
order to get up to speed with the new Standard’s impairment requirements:
• s tudy the impairment requirements and
evaluate how the information will be
accumulated
•create and maintain buy-in from senior
management within your organisation
for the project
•compile information about existing
contracts in order to gauge the
Standard’s impact and decide whether
and how to group them together
•review loan covenants and other
agreements that incorporate financial
ratios and metrics, such as
compensation arrangements, that
could be affected by the new Standard
•communicate what is happening and
how it affects the entity, for example by:
−
explaining how default will be defined
−explaining how the entity will
determine what is a significant
increase in credit risk
−providing enough information to
allow for comparisons over time
Key implementation challenges
Estimating PDs and LGDs
Write-off policy
Meaning of ‘default’?
What is ‘low credit risk’?
How to group assets (shared
credit risk characteristics)
Assessing significant
increase in credit risk
•consider how you will approach the
calculation of the ‘probability of default’
(PDs) and ‘loss given defaults’ (LGDs)
• decide whether to use practical
expedients
•monitor progress towards interim and
final milestones and intervene where
required.
We hope you find the information in this publication helpful in getting you ready for
IFRS 9. If you would like to discuss any of the points raised, please speak to your usual
Grant Thornton contact or visit www.grantthornton.global/locations to find your
local member firm.
Issue 2 March 2016 37
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